Investments in commodity refer to trading in such assets like grain, oil, gold and silver and other precious metal. There are various methods to invest in commodities like an investor can invest in futures contracts, commodity-based mutual funds, or can buy a physical asset, such as a bar of gold. Investing in commodities is different from other investment it is not like investing in normal stocks and bonds. Trading of commodities is usually carried out as futures contracts on a commodities exchange. Many investors refer quality commodity tips, gold and silver tips for earning a better return on investment.
Examples of commodities include gold, silver, wheat, rice, coffee beans, sugar, salt, etc. There are two types of commodity first Soft commodities that are goods that generally are grown, while hard commodities are extracted from mining.
There are many advantages and disadvantages of the commodities markets. At one side it provides better opportunity to earn a profit while it also considered as high-risk, high-reward investments. If you have too many commodity investments in your portfolio, sometimes it might be dangerous for you.
Advantages of commodity trading:
- Higher growth opportunities. A rapidly increasing demand for a commodity can see increases in prices significantly time to time. It provides a lot of opportunities to make quick income through commodity investment.
- Diversification – Diversification is when you invest in a variety of industries that give results differently to changes in the market. It will keep your annual profit stable and also avoid big losses. If you’re looking to hedge against your stock and bond investments, investing in commodities can be the right option for you manage risk in the stock market.
- Provide security against inflation. Inflation is bad for regular trading. At the time of inflation, it down your stock and bond investment profit while commodities usually positive in the time of inflation. Because when the price of goods and services increase, the value of commodities needed to produce these goods and services will automatically rise. By keeping some commodities in your investment portfolio, you can take advantage of market upswing.
- Leverage: Commodity futures operate on margin, meaning that to take a position only a fraction of the total value needs to be available in cash in the trading account.
- Commission costs: It is a lot cheaper to buy/sell one futures contract than to buy/sell the underlying instrument. For example, one full size MCX GOLD contract is currently worth in excess of 35,00,000 INR and could be bought/sold for as little as 100,000 INR. The expense of buying/selling 35,00,000 INR could be 100,000 INR + or -.
- Liquidity: The involvement of speculators means that futures contracts are reasonably liquid. However, how liquid depends on the actual contract being traded. Electronically traded contracts, such as the e-minis tend to be the most liquid whereas the pit traded commodities like corn, orange juice etc are not so readily available to the retail trader and are more expensive to trade in terms of commission and spread.
- Ability to go short: Futures contracts can be sold as easily as they are bought enabling a speculator to profit from falling markets as well as rising ones. There is no uptick rule for example like there is with stocks.
- No Time Decay: Options suffer from time decay because the closer they come to expiry the less time there is for the option to come into the money. Commodity futures do not suffer from this as they are not anticipating a particular strike price at expiry.
Benefits of Investing in Commodities:
A Safe Refuge during Crisis
Often investors do not feel confident about investing in commodities but think about precious metals like silver, gold, and platinum; they offer a clear protection during inflation and times of economic uncertainty. They are a good source of investment even during tough times.
Diversified Investment Portfolio
An ideal asset allocation plan means having a diversified portfolio. Commodities are an important component of having a diversified investment portfolio. If you are already investing in stocks and bonds, it is suggested that you consider investing in raw materials simultaneously. This way, whenever there is a stock market crash, you are not putting all your eggs in a single basket.
Often, the values of commodities see a downfall just like stock market shares. They react differently in various geo-political and economic scenarios. Diversification, thus, is more likely to improve risk-adjusted returns and reduce volatility.
Transparency in the Process
Trading in commodity futures is a transparent process. The course of action leads you to fair price discovery which is controlled by large-scale participation. Such a huge participation also reflects different perspectives and outlook of a wider section of people who are dealing with that commodity.
Commodities are riskier form of investments with huge swings in prices. Companies either hit it right on a resource discovery or experience heavy losses. This opens up opportunities for you to make profits in the commodity market provided you plan your investments right.
Whenever the rupee becomes less valuable, you need more money to buy commodity goods from different parts of the world. Especially during inflation, the prices of commodity goods go up as other investors sell off their stocks and bonds to invest in commodities. Therefore, you can be benefit from some commodities in your portfolio that act as a potential hedge against risks.
Protection against Inflation
When the economy is dipping, money is worth less – inflation occurs. The prices for commodities usually go up during high inflation; accordingly the price of raw materials also sees an upward trend. Therefore, a few commodities in your portfolio will help you benefit from this upswing.
Trading on Lower Margin
As a trader, you need to deposit a margin with your broker which can be close to 5 to 10% of the total value of contract, which is much lower considering other asset classes. Such a low margin allows you to take larger positions at a lesser capital.